The Bombay index had lost as much as 4.7 percent earlier -- its biggest intraday fall since a 17 percent crash on May 17, 2004. The stock market weakness, coupled with the dollar's strength, took a toll on the rupee, which lost 0.6 percent.

The index fell 2.9 percent to 6,458.84 points, its lowest close since Dec. 23, swinging 292 points between the day's high and low. Twenty-nine of the index's 30 stocks lost ground, with autos, banks and metals feeling the brunt of the sell-off.

"This is a very healthy correction and was long overdue," said Raamdeo Agarwal, managing director at stock broker Motilal Oswal. "People should realise that this is not a one-way street."

The interest rate-sensitive auto and banking sectors fell sharply, while metal stocks were dragged down by a heavy sell-off on the London Metal Exchange overnight.

Compared with a 73 percent leap in 2003, the Bombay index rose just 13 percent in 2004, though that represented a 56 percent rebound from its May 17 low.

The market then started 2005 as it finished last year, racing to a record intraday peak of 6,696.31 points on Tuesday as foreign investors continued to pump money into Asia's fourth-largest economy on hopes of good returns.

Foreign funds moved a net $8.5 billion into Indian shares last year, helping stocks recover from lows in May after the Congress party surprisingly won a national election and formed a government with support from communists wary of economic reforms.

Overseas funds then bought more than $120 million worth of Indian stocks on the first two trading days of 2005, though data for Wednesday will not be available until later on Thursday.

RUPEE AND BONDS EASE

Strong foreign inflows had also buoyed the rupee last year, helping it rise 4.9 percent on top of a 5.2 percent gain in 2003.

But the Indian currency, which hit a 5-year peak on Dec. 31, slipped due to a dollar rebound abroad and expectations that a sharp decline in stock prices would weigh on foreign investment.

The rupee ended at 43.8350/8500 per dollar -- its lowest since Dec. 27 -- down from its previous 43.52/54 close.

Federal bonds eased after a recent rally, hit by the falls in the equity and currency markets as traders digest Tuesday's fresh issues and look forward to more debt sales next week.

The benchmark 10-year yield was at 6.5542 percent, above the previous close of 6.4723 percent.

Member

Spillsville on the Sensex: First, it seethed. Then it simmered, and in one swift splash, boiled over.

Some say they saw it coming, and took them back to Black Monday eight months ago. On Wednesday, the sensex took a 317-point dive on some tough talking by the US Fed, an already burgeoning outstanding position, a crash in metal prices, and the seemingly phoenix-like rise of the dollar.

These circumstances spooked both foreign and local investors. Too add to this, a minor earthquake on Nasdaq made the BSE quiver, shedding over Rs 68,000 crore of shareholder wealth in a single day.

Valuations had run up. The market seemed ripe for correction. The Feds position and the strength of the dollar only gave it the necessary push, said the CEO of a large domestic mutual fund.

The sensex fell 317 points to an intra-day low of 6334.74, before recovering to close 192.17 points or 2.89% down at 6458. This is the biggest single intra-day fall since May 17 last year, when it tumbled 842 points or 17% on anxiety over the change in regime at the Centre.

Wednesdays fall is also the seventh largest since 01 and 28th largest in the history of the index. Street-savvy readers of ET should know that the over-heated market was about to wind down its positions. On the first trading day of the new year, January 3, ET had predicted volatile days, warning investors of the dangers that lay ahead.

The broad-based Nifty fell 113 points to the days low of 1990 before recovering to 2032, down 3.4%. The index had been slipping steadily throughout the day, but plunged below 2000 after 2 pm, before recovering slightly.

LIC, the biggest Indian institutional investor, said it might use the opportunity to buy. We will look for opportunities to buy, said LIC chairman RN Bharadwaj.

Market sources said the partial recovery towards the closing was on the back of LIC and UTI purchases.

Two days ago, the sensex had welcomed 05 with a 76-point salute that suggested that the momentum generated in 04 would continue.

The index had risen 52.7% from its 52-week low of 4227 on May 17 to end 04 on a high note, spurred largely by generous foreign fund inflows.

That euphoria, however, has proved to be short-lived.

A hawkish signal from the US Federal Reserve, which released minutes of its December meeting on Tuesday, suggested that it may move soon to hike US interest rates.

The Fed said that the target rate is less than that needed to slow inflation after five increases last year. The stance is seen in many circles as a prelude to further increases in US rates, currently at 2.25%, especially as it comes on the back of optimistic news about the American economy.

The dollar jumped immediately on the news, rising to its highest in three weeks versus the euro in early New York trade on Wednesday. The greenback is rising for the fourth straight day against the euro after falling 7.1% versus the currency in 04.

In the domestic currency markets, the dollar climbed 20 paise as investors bet that dollar assets would be attractive in a rising interest rate scenario.

This is crucial as a good amount of FII interest in Indian stocks in 04 was generated by the appreciation of the rupee versus the greenback. That made domestic assets more attractive.

But with signs pointing to an increased interest in the dollar, investors, especially FIIs, may prefer greenback-denominated assets, analysts said.

Hedge funds and other FIIs are also believed to have led selling in India. Estimates range from Rs 100 to Rs 300 crore of stocks sold. Buying by LIC and UTI sparked a late afternoon recovery though analysts advised caution.

Short term investors need to be careful. The next few months are likely to be volatile, said a senior industry official.

Metal, banking and technology stocks were the biggest losers. Prices of copper, aluminium and zinc tumbled on the London Metal Exchange, affecting prices of metal companies in the domestic market.

Banking was also hit hard. It lost about Rs 8,005 crore in market capitalisation, followed by IT, which lost Rs 6,764 crore. The market capitalisation of the Bombay Stock Exchange fell by Rs 68,196 crore, while that of the NSE fell by Rs 56,103 crore.